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CERNER CORP /MO/ - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge)
The following Management Discussion and Analysis (MD&A) is intended to help the
reader understand our results of operations and financial condition. This MD&A
is provided as a supplement to, and should be read in conjunction with, our
financial statements and the accompanying notes to the financial statements
(Notes).
Our fiscal year ends on the Saturday closest to December 31. Fiscal years 2012,
2011 and 2010 each consisted of 52 weeks and ended on December 29, 2012,
December 31, 2011 and January 1, 2011, respectively. All references to years in
this MD&A represent fiscal years unless otherwise noted.
Management Overview
Our revenues are primarily derived by selling, implementing and supporting
software solutions, clinical content, hardware, devices and services that give
health care providers secure access to clinical, administrative and financial
data in real time, allowing them to improve quality, safety and efficiency in
the delivery of health care.
Our fundamental strategy centers on creating organic growth by investing in
research and development (R&D) to create solutions and services for the health
care industry. This strategy has driven strong growth over the long-term, as
reflected in five- and ten-year compound annual revenue growth rates of 12% or
more. This growth has also created an important strategic footprint in health
care, with Cerner® solutions licensed by approximately 10,000 facilities around
the world, including more than 2,700 hospitals; 4,150 physician practices;
45,000 physicians; 550 ambulatory facilities, such as laboratories, ambulatory
centers, behavioral health centers, cardiac facilities, radiology clinics and
surgery centers; 800 home health facilities; 45 employer sites and 1,750 retail
pharmacies. Selling additional solutions back into this client base is an
important element of our future revenue growth. We are also focused on driving
growth through market share expansion by strategically aligning with health care
providers that have not yet selected a supplier and by displacing competitors in
health care settings that are looking to replace their current supplier.
We expect to drive growth through new initiatives and services that reflect our
ongoing ability to innovate and expand our reach into health care. Examples of
these include our CareAware® health care device architecture and devices,
employer services, Cerner ITWorks services, Cerner RevWorks services, and
solutions on our Healthe Intent platform. Finally, we believe there is
significant opportunity for growth outside of the United States, with many
non-U.S. markets focused on HCIT as part of their strategy to improve the
quality and lower the cost of health care.
Beyond our strategy for driving revenue growth, we are also focused on earnings
growth. Similar to our history of growing revenue, our net earnings have
increased at compound annual rates of more than 20% over the most recent five-
and ten-year periods. We expect to drive continued earnings growth through
ongoing revenue growth coupled with margin expansion, which we expect to achieve
through efficiencies in our implementation and operational processes and by
leveraging R&D investments and controlling general and administrative expenses.
We are also focused on continuing to deliver strong levels of cash flow, which
we expect to do by continuing to grow earnings and prudently managing capital
expenditures.
Results Overview
The Company delivered strong levels of bookings, revenues, earnings and cash
flows in 2012.
New business bookings revenue in 2012, which reflects the value of executed
contracts for software, hardware, professional services and managed services,
was $3.1 billion, which is an increase of 15% compared to $2.7 billion in 2011.
Our 2012 revenues increased 21% to $2.7 billion compared to $2.2 billion in
2011. The year-over-year increase in revenue reflects improved economic
conditions, ongoing demand related to the HITECH Act, and increased
contributions form new initiatives, such as device resale, Cerner ITWorks and
Cerner RevWorks.
Our 2012 net earnings increased 30% to $397.2 million compared to $306.6 million
in 2011. Diluted earnings per share increased 28% to $2.26 compared to $1.76 in
2011. The 2012 and 2011 net earnings and diluted earnings per share reflect the
impact of stock-based compensation expense. The effect of these expenses reduced
the 2012 net earnings and diluted earnings per share by $23.5 million and $0.13,
and the 2011 earnings and diluted earnings per share by $18.2 million and $0.11,
respectively. The growth in net earnings and diluted earnings per share was
driven primarily by strong revenue growth and continued progress with our margin
expansion initiatives, including efficiencies in our implementation and
operational
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processes, leveraging R&D investments and controlling general and administrative
expenses. Our full-year 2012 operating margin of 21.4% reflects an increase of
50 basis points compared to 2011, which was driven by strong margin expansion in
our core business that was somewhat offset by record levels of lower-margin
technology resale.
We had cash collections of receivables of $2.7 billion in 2012 compared to $2.2
billion in 2011. Days sales outstanding was 74 days for the 2012 fourth quarter
compared to 73 days for the 2012 third quarter and 83 days for the 2011 fourth
quarter. Operating cash flows for 2012 were strong at $708.3 million compared to
$546.3 million in 2011.
Health Care Information Technology Market Outlook
We have provided a detailed assessment of the health care information technology
market under "Health Care and Health Care IT Industry" in Part I, Item 1
"Business."
Results of Operations
Fiscal Year 2012 Compared to Fiscal Year 2011
% of % of
(In thousands) 2012 Revenue 2011 Revenue % Change
Revenues
System sales $ 902,799 34 % $ 706,714 32 % 28 %
Support and maintenance 604,247 23 % 550,554 25 % 10 %
Services 1,103,082 41 % 901,193 41 % 22 %
Reimbursed travel 55,308 2 % 44,692 2 % 24 %
Total revenues 2,665,436 100 % 2,203,153 100 % 21 %
Costs of revenue
Costs of revenue 608,197 23 % 441,672 20 % 38 %
Total margin 2,057,239 77 % 1,761,481 80 % 17 %
Operating expenses
Sales and client service 1,020,640 38 % 869,962 39 % 17 %
Software development 301,370 11 % 286,801 13 % 5 %
General and administrative 163,567 6 % 144,920 7 % 13 %
Total operating expenses 1,485,577 56 % 1,301,683 59 %
14 %
Total costs and expenses 2,093,774 79 % 1,743,355 79 %
20 %
Operating earnings 571,662 21 % 459,798 21 % 24 %
Other income, net 16,046 9,896
Income taxes (190,476 ) (163,067 )
Net earnings $ 397,232 $ 306,627 30 %
Revenues & Backlog
Revenues increased 21% to $2.7 billion in 2012, as compared to $2.2 billion in
2011.
• System sales, which include revenues from the sale of licensed software,
software as a service, technology resale (hardware, devices, and
sublicensed software), deployment period licensed software upgrade rights,
installation fees, transaction processing and subscriptions, increased 28%
to $902.8 million in 2012 from $706.7 million for the same period in 2011.
The increase in system sales was driven by record levels of technology
resale and solid growth in subscriptions and software.
• Support and maintenance revenues increased 10% to $604.2 million in 2012
compared to $550.6 million during the same period in 2011. This increase
was attributable to continued success at selling Cerner Millennium
applications and implementing them at client sites. We expect that support
and maintenance revenues will continue to grow as the base of installed
Cerner Millennium systems grows.
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• Services revenue, which includes professional services, excluding
installation, and managed services, increased 22% to $1.1 billion in 2012
from $0.9 billion for the same period in 2011. This increase was driven by
growth in CernerWorks managed services as a result of continued demand for
our hosting services and an increase in professional services due to
increased implementation activities and growth in Cerner ITWorks services.
Contract backlog, which reflects new business bookings that have not yet been
recognized as revenue, increased 21% in 2012 when compared to 2011. This
increase was driven by growth in new business bookings during the past four
quarters, including continued strong levels of managed services and Cerner
ITWorks services bookings that typically have longer contract terms.
A summary of total backlog at the end of 2012 and 2011 follows:
(In thousands)
2012 2011
Contract backlog $ 6,534,564 $ 5,401,427
Support and maintenance backlog 738,154 705,744
Total backlog $ 7,272,718 $ 6,107,171
Costs of Revenue
Cost of revenues as a percentage of total revenues was 23% in 2012, compared to
20% in the same period of 2011. The higher cost of revenues as a percent of
revenue was driven by a higher mix of technology resale, which carries a higher
cost of revenue.
Cost of revenues includes the cost of reimbursed travel expense, sales
commissions, third party consulting services and subscription content and
computer hardware, devices and sublicensed software purchased from manufacturers
for delivery to clients. It also includes the cost of hardware maintenance and
sublicensed software support subcontracted to the manufacturers. Such costs, as
a percent of revenues, typically have varied as the mix of revenue (software,
hardware, devices, maintenance, support, services and reimbursed travel)
carrying different margin rates changes from period to period. Cost of revenues
does not include the costs of our client service personnel who are responsible
for delivering our service offerings. Such costs are included in sales and
client service expense.
Operating Expenses
Total operating expenses increased 14% to $1.5 billion in 2012, compared with
$1.3 billion in 2011.
• Sales and client service expenses as a percent of total revenues were 38%
in 2012, compared to 39% in the same period of 2011. These expenses
increased 17% to $1.0 billion in 2012, from $0.9 billion in the same
period of 2011. Sales and client service expenses include salaries of
sales and client service personnel, depreciation and other expenses associated with our CernerWorks managed service business, communications
expenses, unreimbursed travel expenses, expense for share-based payments,
sales and marketing salaries and trade show and advertising costs. The
decrease as a percent of revenue reflects ongoing efficiencies in our
implementation and operational processes.
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• Software development expenses as a percent of revenue were 11% in 2012,
compared to 13% in 2011. Expenditures for software development reflect
ongoing development and enhancement of the Cerner Millennium platform,
including investments in the next evolution of Cerner Millennium,
Millennium+, which leverages the cloud and enables greater mobility. The
reduction as a percentage of revenue reflects our efforts to control
spending relative to revenue growth. Because of the strong platform we have built, we are able to continue advancing our solutions and investing
in new solutions without large increases in spending. Expense was also
limited by a higher percentage of our software development investments
being capitalized, which we expect to continue, as a higher percent of our
development initiatives are focused on new functionality versus
maintenance. A summary of our total software development expense in 2012
and 2011 is as follows:
For the Years Ended
(In thousands) 2012 2011
Software development costs $ 319,828 $ 290,645
Capitalized software costs (98,067 ) (81,417 )Capitalized costs related to share-based payments (2,122 ) (1,525 )
Amortization of capitalized software costs
81,731 79,098
Total software development expense $ 301,370 $ 286,801
• General and administrative expenses as a percent of total revenues were 6%
in 2012, compared to 7% in 2011. These expenses increased 13% to $163.6
million in 2012, from $144.9 million for the same period in 2011. General
and administrative expenses include salaries for corporate, financial and
administrative staffs, utilities, communications expenses, professional
fees, transaction gains or losses on foreign currency and expense for
share-based payments. The increase in general and administrative expenses
was primarily driven by an increase in corporate personnel costs, as we
have continued to increase such personnel to support our overall revenue
growth.
Non-Operating Items
• Interest income increased to $16.5 million in 2012 from $15.2 million in
2011 due primarily to growth in investments. Interest expense decreased to
$5.1 million in 2012 compared to $5.3 million in 2011 due primarily to
payments on our long-term debt, offset by increased capital lease
obligations. Other income in 2012 also includes a $4.5 million gain
recognized on the disposition of one of our cost-method investments.
• Our effective tax rate decreased to 32% in 2012 from 35% in 2011. This
decrease was primarily due to an increase in net favorable permanent
differences, along with a favorable adjustment to our unrecognized tax
benefits, partially offset by the expiration of the research and
development tax credit on December 31, 2011. We do not expect the
favorable impact of permanent differences to be as significant in 2013. We
also do not expect any significant favorable adjustments to our
unrecognized tax benefits in 2013. Refer to Note (12) of the notes to
consolidated financial statements for further information regarding our
effective tax rate.
In January 2013, the American Taxpayer Relief Act of 2012 (Act) became law. The
Act reinstates the research and development tax credit retroactively from
January 1, 2012 to December 31, 2013. In the first quarter of 2013, we will
recognize the research and development tax credit related to 2012 as a favorable
discrete item. Research and development tax credits generated in 2013 will be
recognized pro-rata over that year as a component of the overall 2013 effective
tax rate.
Operations by Segment
We have two operating segments: Domestic and Global. The Domestic segment
includes revenue contributions and expenditures associated with business
activity in the United States. The Global segment includes revenue contributions
and expenditures linked to business activity in Argentina, Aruba, Australia,
Austria, Canada, Cayman Islands, Chile, China (Hong Kong), Egypt, England,
France, Germany, Guam, India, Ireland, Italy, Japan, Malaysia, Mexico, Morocco,
Puerto Rico, Qatar, Saudi Arabia, Singapore, Spain, Sweden, Switzerland and the
United Arab Emirates.
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The following table presents a summary of the operating information for the
years ended 2012 and 2011:
(In thousands) 2012 % of Revenue 2011 % of Revenue % Change
Domestic Segment
Revenues $ 2,341,304 100% $ 1,894,454 100% 24%
Costs of revenue 548,813 23% 387,466 20% 42%
Operating expenses 506,249 22% 439,465 23% 15%
Total costs and expenses 1,055,062 45% 826,931 44% 28%
Domestic operating earnings 1,286,242 55% 1,067,523 56% 20%
Global Segment
Revenues 324,132 100% 308,699 100% 5%
Costs of revenue 59,384 18% 54,206 18% 10%
Operating expenses 131,580 41% 126,997 41% 4%
Total costs and expenses 190,964 59% 181,203 59% 5%
Global operating earnings 133,168 41% 127,496 41% 4%
Other, net (847,748 ) (735,221 ) 15%
Consolidated operating earnings $ 571,662 $ 459,798 24%
Domestic Segment
• Revenues increased 24% to $2.3 billion in 2012 from $1.9 billion in 2011.
This increase was primarily driven by strong growth in technology resale
and professional services.
• Cost of revenues was 23% of revenues in 2012, compared to 20% of revenues
in 2011. The higher cost of revenues as a percent of revenue was primarily
driven by a higher mix of technology resale, which carries a higher cost
of revenue.
• Operating expenses increased 15% to $506.2 million in 2012 from $439.5
million in 2011, due primarily to growth in managed services and
professional services expenses.
Global Segment
• Revenues increased 5% to $324.1 million in 2012 from $308.7 million in
2011. This increase was primarily driven by growth in technology resale
and managed services, along with a higher level of support services.
Growth in our Global Segment revenues has lagged our faster rate of
revenue growth in our Domestic Segment due to the more significant impact
of the economic downturn of the last several years on the non-U.S.
countries in which we conduct operations.
• Cost of revenues was 18% in 2012 and 2011, due to a similar mix of sales.
• Operating expenses were at $131.6 million in 2012, compared to $127.0
million in 2011, primarily due to overall growth in our Global segment.
Other, net
Operating results not attributed to an operating segment include expenses, such
as centralized professional services costs, software development, marketing,
general and administrative, stock-based compensation, depreciation, and
amortization. These expenses increased 15% to $847.7 million in 2012 from $735.2
million in 2011. This increase was primarily due to growth in corporate and
development personnel costs.
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Fiscal Year 2011 Compared to Fiscal Year 2010
% of % of
(In thousands) 2011 Revenue 2010 Revenue % Change
Revenues
System sales $ 706,714 32 % $ 550,792 30 % 28 %
Support and maintenance 550,554 25 % 517,494 28 % 6 %
Services 901,193 41 % 749,483 40 % 20 %
Reimbursed travel 44,692 2 % 32,453 2 % 38 %
Total revenues 2,203,153 100 % 1,850,222 100 % 19 %
Costs of revenue
Costs of revenue 441,672 20 % 320,356 17 % 38 %
Total margin 1,761,481 80 % 1,529,866 83 % 15 %
Operating expenses
Sales and client service 869,962 39 % 767,152 42 % 13 %
Software development 286,801 13 % 272,851 15 % 5 %
General and administrative 144,920 7 % 130,530 7 % 11 %
Total operating expenses 1,301,683 59 % 1,170,533 64 %
11 %
Total costs and expenses 1,743,355 79 % 1,490,889 81 %
17 %
Operating earnings 459,798 21 % 359,333 19 % 28 %
Other income, net 9,896 2,879
Income taxes (163,067 ) (124,940 )
Net earnings $ 306,627 $ 237,272 29 %
Revenues & Backlog
Revenues increased 19% to $2.2 billion in 2011, as compared to $1.9 billion in
2010.
• System sales increased 28% to $706.7 million in 2011 from $550.8 million
in 2010. The increase in system sales was driven by strong increases in
licensed software, technology resale, and subscriptions.
• Support and maintenance revenues increased 6% to $550.6 million in 2011
compared to $517.5 million in 2010. This increase was attributable to
continued success at selling Cerner Millennium applications and
implementing them at client sites.
• Services revenue increased 20% to $901.2 million in 2011 compared to $749.5 million in 2010. This increase was driven by growth in CernerWorks
managed services as a result of continued demand for our hosting services
and an increase in professional services due to increased implementation
activities and growth in Cerner ITWorks services.
Contract backlog, which reflects new business bookings that have not yet been
recognized as revenue, increased 26% in 2011 compared to 2010. This increase was
driven by growth in new business bookings during 2011, including continued
strong levels of managed services and Cerner ITWorks bookings that typically
have longer contract terms.
A summary of total backlog at the end of 2011 and 2010 follows:
(In thousands)
2011 2010
Contract backlog $ 5,401,427 $ 4,285,267
Support and maintenance backlog 705,744 654,913
Total backlog $ 6,107,171 $ 4,940,180
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Costs of Revenue
Cost of revenues as a percentage of total revenues was 20% of total revenues in
2011, as compared to 17% of total revenues in 2010. The higher cost of revenues
as a percent of revenue was primarily driven by a higher mix of technology
resale, which carries a higher cost of revenue, and a slightly higher level of
third party consulting costs.
Operating Expenses
Total operating expenses increased 11% in 2011 to $1.3 billion as compared to
$1.2 billion in 2010.
• Sales and client service expenses as a percent of total revenues were 39%
in 2011, as compared to 42% in 2010. These expenses increased 13% to
$870.0 million in 2011, from $767.2 million in 2010. The increase in these
expenses was primarily attributable to growth in the managed services
business and a higher level of professional services expenses. The
decrease as a percent of revenue reflected efficiencies in our
implementation and operational processes.
• Software development expenses as a percent of revenue were 13% in 2011, as
compared to 15% in 2010. These expenses increased 5% in 2011 to $286.8
million, from $272.9 million in 2010. Expenditures for software
development in 2011 reflected continued development and enhancement of the
Cerner Millennium platform and software solutions and investments in new
growth initiatives. Although these expenses increased in 2011, the
reduction as a percent of revenue reflected our ongoing efforts to control
spending relative to revenue growth. A summary of our total software
development expense in 2011 and 2010 is as follows:
For the Years Ended
(In thousands) 2011 2010
Software development costs $ 290,645 $ 284,836
Capitalized software costs (81,417 ) (79,631 )
Capitalized costs related to share-based payments (1,525 ) (1,348 )
Amortization of capitalized software costs
79,098 68,994
Total software development expense $ 286,801 $ 272,851
• General and administrative expenses as a percent of total revenues were 7%
in 2011 and 2010. These expenses increased 11% to $144.9 million in 2011
from $130.5 million in 2010. An increase in corporate personnel costs
accounted for the majority of the overall increase in general and administrative expenses, as we increased personnel to support our overall
revenue growth.
Non-Operating Items
• Interest income increased to $15.2 million in 2011 from $10.3 million in
2010 due primarily to growth in investments and related increase in
investment returns. Interest expense decreased to $5.3 million in 2011
from $6.9 million in 2010 due to payment on our long-term debt.
• Our effective tax rate was 35% in 2011, as compared to 34% in 2010. The
increase was attributable to the mix of domestic and foreign earnings.
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Operations by Segment
The following table presents a summary of our operating segment information for
the years ended 2011 and 2010:
(In thousands) 2011 % of Revenue 2010 % of Revenue % Change
Domestic Segment
Revenues $ 1,894,454 100% $ 1,562,563 100% 21%
Costs of revenue 387,466 20% 272,385 17% 42%
Operating expenses 439,465 23% 417,181 27% 5%
Total costs and expenses 826,931 44% 689,566 44% 20%
Domestic operating earnings 1,067,523 56% 872,997 56% 22%
Global Segment
Revenues 308,699 100% 287,659 100% 7%
Costs of revenue 54,206 18% 47,971 17% 13%
Operating expenses 126,997 41% 124,546 43% 2%
Total costs and expenses 181,203 59% 172,517 60% 5%
Global operating earnings 127,496 41% 115,142 40% 11%
Other, net (735,221 ) (628,806 ) 17%
Consolidated operating earnings $ 459,798 $ 359,333 28%
Domestic Segment
• Revenues increased 21% to $1.9 billion in 2011 from $1.6 billion in the
same period in 2010. This increase was driven by growth across all
business models, with particular strength in licensed software, technology
resale, professional services and managed services.
• Cost of revenues increased to 20% of revenues in 2011, compared to 17% in
2010. The higher cost of revenues as a percent of revenue was primarily
driven by a higher mix of technology resale, which carries a high cost of
revenue, and an increase in third party consulting costs.
• Operating expenses increased 5% to $439.5 million in 2011, from $417.2
million in 2010, due primarily to growth in managed services and
professional services expense.
Global Segment
• Revenues increased 7% to $308.7 million in 2011 from $287.7 million in
2010. Global revenues increased due to an increase in licensed software
and managed services revenue, which was partially offset by a decrease in
professional services and technology resale revenue. The global
comparisons were also impacted by a change in certain contract accounting
estimates during the first quarter of 2010.
• Cost of revenues was 18% and 17% in 2011 and 2010, respectively. The
higher cost of revenues in 2011 was primarily driven by an increase in
third party professional services costs.
• Operating expenses increased 2% to $127.0 million in 2011 from $124.5
million in 2010, which was primarily to support our revenue growth.
Other, net
These expenses increased 17% to $735.2 million in 2011 from $628.8 million in
2010. This increase was primarily due to increased costs in software
development, increased corporate and development personnel costs, increased
stock compensation costs, and growth in other professional services.
Liquidity and Capital Resources
Our liquidity is influenced by many factors, including the amount and timing of
our revenues, our cash collections from our clients and the amount we invest in
software development, acquisitions and capital expenditures.
Our principal sources of liquidity are our cash, cash equivalents, which consist
of money market funds and time deposits
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with original maturities of less than 90 days, and short-term investments. At
the end of 2012, we had cash and cash equivalents of $317.1 million and
short-term investments of $719.7 million, as compared to cash and cash
equivalents of $243.1 million and short-term investments of $531.6 million at
the end of 2011.
Approximately 15% of our aggregate cash, cash equivalents and short-term
investments at December 29, 2012, were held outside of the United States. As
part of our business strategy, we plan to indefinitely reinvest the earnings of
our foreign operations; however, should the earnings of our foreign operations
be repatriated, we would accrue and pay tax on such earnings, which may be
material.
Additionally, we maintain a $100.0 million multi-year revolving credit facility,
which expires in February 2017. The facility provides an unsecured revolving
line of credit for working capital purposes, along with a letter of credit
facility. Interest is payable at a rate based on prime, LIBOR, or the U.S.
federal funds rate, plus a spread that varies depending on the leverage ratios
maintained. The agreement provides certain restrictions on our ability to
borrow, incur liens, sell assets and pay dividends and contains certain cash
flow and liquidity covenants. As of the end of 2012, we were in compliance with
all debt covenants. As of the end of 2012, we had no outstanding borrowings
under this agreement; however, we had $14.3 million of outstanding letters of
credit, which reduced our available borrowing capacity to $85.7 million.
We believe that our present cash position, together with cash generated from
operations, short-term investments and, if necessary, our available line of
credit, will be sufficient to meet anticipated cash requirements during 2013.
The following table summarizes our cash flows in 2012, 2011 and 2010:
For the Years Ended
(In thousands) 2012 2011 2010
Cash flows from operating activities $ 708,314 $ 546,294 $ 456,444
Cash flows from investing activities (701,631 ) (565,091 ) (520,896 )
Cash flows from financing activities 66,034 48,853 34,841
Effect of exchange rate changes on cash 1,257 (1,421 ) 2,399
Total change in cash and cash equivalents 73,974 28,635 (27,212 )
Cash and cash equivalents at beginning of period 243,146 214,511
241,723
Cash and cash equivalents at end of period $ 317,120 $ 243,146
$ 214,511
Free cash flow (non-GAAP) $ 424,696 $ 358,557 $ 273,154
Cash from Operating Activities
For the Years Ended
(In thousands) 2012 2011 2010
Cash collections from clients $ 2,714,315 $ 2,211,361 $ 1,900,145
Cash paid to employees and suppliers and other (1,840,682 ) (1,543,414 ) (1,315,077 )
Cash paid for interest (6,448 ) (5,786 ) (6,887 )
Cash paid for taxes, net of refund (158,871 ) (115,867 ) (121,737 )
Total cash from operations $ 708,314 $ 546,294 $ 456,444
Cash flow from operations increased $162.0 million in 2012 compared to 2011 and
$89.9 million in 2011 compared to 2010 due primarily to the increase in cash
impacting earnings, along with cash provided by working capital changes. During
2012, 2011 and 2010, we received total client cash collections of $2.7 billion,
$2.2 billion and $1.9 billion, respectively, of which 3%, 3% and 4%,
respectively, were received from third party client financing arrangements and
non-recourse payment assignments. Days sales outstanding was 74 days in the
fourth quarter of 2012, 73 days in the third quarter of 2012 and 83 days in the
fourth quarter of 2011. Revenues provided under support and maintenance
agreements represent recurring cash flows. Support and maintenance revenues
increased 10% in 2012 and 6% in 2011. We expect these revenues to continue to
grow as the base of installed Cerner Millennium systems grows.
Cash from Investing Activities
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For the Years Ended
(In thousands) 2012 2011 2010
Capital purchases $ (183,429 ) $ (104,795 ) $ (102,311 )
Capitalized software development costs (100,189 ) (82,942 ) (80,979 )
Purchases of investments, net of sales and maturities (354,603 ) (291,393 ) (312,340 )
Other, net (63,410 ) (85,961 ) (25,266 )
Total cash flows from investing activities $ (701,631 ) $ (565,091 ) $ (520,896 )
Cash flows from investing activities consist primarily of capital spending and
our short-term investment activities. Capital spending consists of capitalized
equipment purchases primarily to support growth in our CernerWorks managed
services business, building and improvement purchases to support our facilities
requirements and capitalized spending to support our ongoing software
development initiatives. Capital spending is expected to increase in 2013,
primarily due to capital purchases associated with new office space and spending
related to software development initiatives; however, we still expect strong
levels of free cash flow.
Short-term investment activity consists of the investment of cash generated by
our business in excess of what is necessary to fund operations. We expect to
continue such short-term investment activity in 2013, as we expect strong levels
of cash flow.
During 2012, we completed our acquisition of Anasazi Software, Inc. for $40.5
million, net of cash acquired. During 2011, we completed our acquisitions of
Resource Systems, Inc. and Clairvia, Inc. for approximately $28.1 million and
$37.2 million, net of cash acquired, respectively. During 2010, we completed our
acquisition of IMC Health Care, Inc. for approximately $14.5 million, net of
cash acquired. We expect to continue seeking and completing strategic business
acquisitions that are complementary to our business.
Cash from Financing Activities
For the Years Ended
(In thousands) 2012 2011 2010
Repayment of long-term debt and capital lease obligations $ (17,083 ) $ (25,701 ) $ (27,625 )
Cash from option exercises (including excess tax benefits) 86,517 75,333 60,950
Other, net (3,400 ) (779 ) 1,516
Total cash flows from financing activities $ 66,034 $ 48,853 $ 34,841
Cash inflows from stock option exercises are dependent on a number of factors,
including the price of our common stock, grant activity under our stock option
and equity plans, and overall market volatility. We expect cash inflows from
stock option exercises to continue in 2013 based on the number of exercisable
options at the end of 2012 and our current stock price.
Free Cash Flow
For the Years Ended
(In thousands) 2012 2011 2010
Cash flows from operating activities (GAAP) $ 708,314 $ 546,294 $ 456,444
Capital purchases
(183,429 ) (104,795 ) (102,311 )
Capitalized software development costs (100,189 ) (82,942 ) (80,979 )
Free cash flow (non-GAAP) $ 424,696 $ 358,557 $ 273,154
Free cash flow increased $66.1 million from 2011 to 2012 and $85.4 million from
2010 to 2011, which we believe reflects continued strength in our earnings. Free
cash flow is a non-GAAP financial measure used by management along with GAAP
results to analyze our earnings quality and overall cash generation of the
business. The presentation of free cash flow is not meant to be considered in
isolation, nor as a substitute for, or superior to, GAAP results and investors
should be aware that non-GAAP measures have inherent limitations and should be
read only in conjunction with our consolidated financial statements prepared in
accordance with GAAP. Free cash flow may also be different from similar non-GAAP
financial measures used by other companies and may not be comparable to
similarly titled captions of other companies due to potential inconsistencies in
the method of calculation. We believe free cash flow is important to enable
investors to better understand
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and evaluate our ongoing operating results and allows for greater transparency
in the review of our overall financial, operational and economic performance,
because free cash flow takes into account the capital expenditures necessary to
operate our business.
Contractual Obligations, Commitments and Off Balance Sheet Arrangements
The following table represents a summary of our contractual obligations and
commercial commitments at the end of 2012, except short-term purchase order
commitments arising in the ordinary course of business.
Payments Due by Period
2018 and
(In thousands) 2013 2014 2015 2016 2017 thereafter Total
Balance sheet
obligations(a):
Long-term debt
obligations $ 24,765 $ 15,015 $ 15,015 $ - $ - $ - $ 54,795
Interest on long-term
debt obligations 2,808 1,664 832 - - - 5,304
Capital lease
obligations 34,817 32,860 32,025 30,214 11,428 - 141,344
Interest on capital
lease obligations 3,900 2,855 1,767 589 94 - 9,205
Other obligations(b):
Operating lease
obligations 24,943 22,843 16,803 12,210 11,911 40,133 128,843
Purchase obligations 39,654 33,052 12,721 2,594 2,184 4,000 94,205
Total $ 130,887 $ 108,289 $ 79,163 $ 45,607 $ 25,617 $ 44,133 $ 433,696
(a) At the end of 2012, liabilities for unrecognized tax benefits were $2.2
million.
(b) At the end of 2012, we had certain obligations related to the construction
of office space in Kansas City, Kansas. Refer to Note (16) of the notes to
consolidated financial statements for information regarding the construction.
We have no off balance sheet arrangements as defined in Regulation S-K. The
effects of inflation on our business during 2012, 2011 and 2010 were
insignificant.
Recent Accounting Pronouncements
Refer to Note (1) of the notes to consolidated financial statements for
information regarding recently adopted accounting pronouncements.
Critical Accounting Policies
We believe that there are several accounting policies that are critical to
understanding our historical and future performance, as these policies affect
the reported amount of revenue and other significant areas involving our
judgments and estimates. These significant accounting policies relate to revenue
recognition, software development, potential impairments of goodwill, and income
taxes. These policies and our procedures related to these policies are described
in detail below and under specific areas within this MD&A. In addition, Note (1)
to the consolidated financial statements expands upon discussion of our
accounting policies.
Revenue Recognition
We recognize revenue within our multiple element arrangements, including
software and software-related services, using the residual method. Key factors
in our revenue recognition model are our assessments that installation services
are essential to the functionality of our software, whereas implementation
services are not, and the length of time it takes for us to achieve the delivery
and installation milestones for our licensed software. If our business model
were to change such that implementation services are deemed to be essential to
the functionality of our software, the period of time over which our licensed
software revenue would be recognized would lengthen.
We generally recognize revenue from the sale of our licensed software over two
key milestones, delivery and installation, based on percentages that reflect the
underlying effort from planning to installation. Generally, both milestones are
achieved in the quarter the contracts are executed. If the period of time to
achieve our delivery and installation milestones for our licensed software were
to lengthen, our milestones would be adjusted and the timing of revenue
recognition for our licensed software could materially change.
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We also recognize revenue for certain projects using the percentage of
completion method. Our revenue recognition is dependent upon our ability to
reliably estimate the direct labor hours to complete a project which generally
can span several years. We utilize our historical project experience and
detailed planning process as a basis for our future estimates to complete
current projects. Significant delays in completion of the projects, unforeseen
cost increases or penalties could result in significant reductions to revenue
and margins on these contracts. The actual project results can be significantly
different from the estimated results. When adjustments are identified near or at
the end of a project, the full impact of the change in estimate is recognized in
that period. This can result in a material impact on our results for a single
reporting period.
Software Development Costs
Costs incurred internally in creating computer software solutions and
enhancements to those solutions are expensed until completion of a detailed
program design, which is when we determine that technological feasibility has
been established. Thereafter, all software development costs are capitalized
until such time as the software solutions and enhancements are available for
general release, and the capitalized costs subsequently are reported at the
lower of amortized cost or net realizable value.
Net realizable value is computed as the estimated gross future revenues from
each software solution less the amount of estimated future costs of completing
and disposing of that product. Because the development of projected net future
revenues related to our software solutions used in our net realizable value
computation is based on estimates, a significant reduction in our future
revenues could impact the recovery of our capitalized software development
costs. We historically have not experienced significant inaccuracies in
computing the net realizable value of our software solutions and the difference
between the net realizable value and the unamortized cost has grown over the
past three years. We expect this trend to continue in the future. If we missed
our estimates of net future revenues by 10%, the amount of our capitalized
software development costs would not be impaired.
Capitalized costs are amortized based on current and expected net future revenue
for each software solution with minimum annual amortization equal to the
straight-line amortization over the estimated economic life of the software
solution. We are amortizing capitalized costs over five years. The five-year
period over which capitalized software development costs are amortized is an
estimate based upon our forecast of a reasonable useful life for the capitalized
costs. Historically, use of our software programs by our clients has exceeded
five years and is capable of being used a decade or more.
We expect that major software information systems companies, large information
technology consulting service providers and systems integrators and others
specializing in the health care industry may offer competitive products or
services. The pace of change in the HCIT market is rapid and there are frequent
new product introductions, product enhancements and evolving industry standards
and requirements. As a result, the capitalized software solutions may become
less valuable or obsolete and could be subject to impairment.
Goodwill
Goodwill is not amortized but is evaluated for impairment annually or whenever
there is an impairment indicator. All goodwill is assigned to a reporting unit,
where it is subject to an annual impairment assessment. We assess goodwill for
impairment in the second quarter of each fiscal year and evaluate impairment
indicators at each quarter end. We assessed our goodwill for impairment in the
second quarters of 2012 and 2011 and concluded that goodwill was not impaired.
The 2012 assessment consisted of a qualitative analysis in accordance with new
guidance effective in 2012. The 2011 assessment consisted of a quantitative
analysis, in which the fair values of each of our reporting units exceeded their
carrying amounts by a significant margin. We used a discounted cash flow
analysis utilizing Level 3 inputs, to determine the fair value of the reporting
units in 2011. Goodwill amounted to $247.6 million and $211.8 million at the end
of 2012 and 2011, respectively. If future anticipated cash flows from our
reporting units that recognized goodwill do not materialize as expected, our
goodwill could be impaired, which could result in significant charges to
earnings.
Income Taxes
We make a number of assumptions and estimates in determining the appropriate
amount of expense to record for income taxes. These assumptions and estimates
consider the taxing jurisdictions in which we operate as well as current tax
regulations. Accruals are established for estimates of tax effects for certain
transactions, business structures and future projected profitability of our
businesses based on our interpretation of existing facts and circumstances. If
these assumptions and estimates were to change as a result of new evidence or
changes in circumstances, the change in estimate could result in a material
adjustment to the consolidated financial statements.
We have discussed the development and selection of these critical accounting
estimates with the Audit Committee of our
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Board of Directors and the Audit Committee has reviewed our disclosure contained
herein.
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